Question
The following information is available for Bright Future Ltd.s capital structure: Equity Financing: 75% by ordinary shares of which the company management just paid a
The following information is available for Bright Future Ltd.s capital structure:
Equity Financing: 75% by ordinary shares of which the company management just paid a $4.55 dividend per share in the curent financial year. The firm is maintaining 6.5 % annual growth rate in dividends, which is expected to continue indefinitely.
Debt Financing: 25% by corporate bonds that pay annually 10.5% coupon rate with an annual before-tax yield to maturity of 9%. The bond issue has face value of $1,000 and will mature in 25 years.
Net income of Bright Future Ltd. in the current financial year is $1,450,750 and the company is considering to invest in one of the two following projects to buy a new assembly line. Each option will last 4 years and have no salvage value at the end. The companys required rate of return for all investment projects is 8.5 %. The cash flows of the projects are provided below.
| Option 1 | Option 2 |
Cost | $392,000 | $425,000 |
Future Cash Flows Year 1 Year 2 Year 3 Year 4 |
157 000 163 000 166 000 175 000 |
165 000 173 000 185 000 188 000 |
Required: Complete the following tasks:
- Calculate the current market value of Bright Future Ltd. ordinary share if the average return of the shares in the same industry is 11.2%? (2 marks)
ANSWER:
- Calculate the current price of the companys corporate bonds? (2 marks)
ANSWER:
- Identify which option of assembly line should the company accept based on Profitability Index
(3 marks) (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
ANSWER:
- Identify which option of machinery should the company accept based on Simple Payback Period method if the company requires a payback of maximum 2 years for all investment projects. (2 marks)
ANSWER:
- Which investment criterion should the companys finance manager recommend for the capital budgeting decision making if the company management would like to know how much each option can increase the shareholder value? (1 mark)
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started